Is It Possible to Specialize in Private Placements As an Investment Advisor or Investment Broker?

private placements

The private placement market is a viable option for raising relatively small amounts of capital. It tends to be populated by smaller companies that do not wish to have the offering registered with the Securities Exchange Commission (SEC). Private placement issuers are not permitted to advertise or solicit investors. Generally, anyone who invests in a private placement must have a liquid net worth of at least $1 million. Institutional investors, pension funds and other professional investing organizations also qualify for private placement investment.

Can an investment advisor or broker specialize in private placement?

Investment advisors and brokers who inform clients regarding the private placement market have two things in common. One, they have connections that provide them with information on private placement offerings. Second, they advise accredited investors or institutional investors.

Because private offerings require wealthy investors, advisors who serve less wealthy clients cannot specialize in the private placement space. Likewise, because the law forbids advertising of private offerings and also prohibits the issuer from soliciting investors, advisors must have connections that allow them to know when offerings are being issued.

Most investment advisors don’t have the connections or enough accredited investor clients to specialize in this space, which makes an investment advisor who has these advantages particularly valuable.

Private placements describe an investment niche for raising capital among accredited investors

The private placement niche offers advantages to both investors and issuers. Many types of companies raise capital with this method, particularly startups. Investors love to get on the ground floor of the next big private placement success, particularly in the tech sector. Private placement investors often include friends and family of the company owners, angel investors and venture capital investors.

The private placement allows the issuer to create more complex securities than simple stock or bond offerings because the investors are accredited or professionals. Some of the securities private placement offerings include the following:

  • Stocks
  • Notes
  • Revenue-sharing securities.
  • Convertible notes.
  • Security agreements for future equity.

Private companies like to raise capital this way because they wish to remain private. In addition, they avoid the time and expense involved with a public stock market offering. The company also saves itself from annual SEC disclosures. If issuing bonds, the company avoids the time and expense of getting a credit rating from a rating agency.

Investors enjoy higher potential returns compared with public offerings. They often gain higher rates of bond interest and can even require the company to provide collateral. Private issuers also often reward investors with higher percentages of stock ownership and fixed dividend payments.

Private placements bear no responsibility to register with the SEC

The Securities Act of 1933 required all public stock offerings to register with the SEC. This regulation was part of The New Deal. Congress and former president Franklin Roosevelt designed the act to protect investors from getting incorrect or fraudulent information about stock offerings, a problem that contributed to the 1929 crash. The act included Regulation D, which provided an exception for private offerings. As a result, private offerings need not submit a prospectus.

Private placements do, however, need to provide disclosures under the law. At the minimum, the issuer produces a term sheet that describes the final terms. Many private placements also include offering memorandums with risk disclosures.

Private placements are generally smaller regarding capital raised than IPOs

Small companies typically use private placements to raise capital. Since their capitalization needs are considerably lower than larger companies, they have no need of the much larger public market. In fact, because private placements are so much less costly, they can raise more capital with less expense. The investors they issue shares to all have deep pockets, so private placement issuers can raise the capital they need from a small circle of investors.

To be an accredited investor, individuals must have a net worth of over $1 million, excluding homes, cars and furnishings. Alternatively, accredited investors qualify if they make more than $200,000 per year ($300,000 for married couples) and have $5 million in net assets. Accreditation is required because private placements represent more risk than regular stocks.

Investors are barred from selling their private shares without registering. As a result, investments tend to be illiquid. It can take a very long time to turn over private placement shares. Since the investor cannot exit the position quickly and may lose significant value, high net worth is needed to absorb these potential blows.

The private placement space works well for wealthy individual investors and institutions or venture capitalists. Investment advisors who have the connections needed to know when private placements are in the pipeline and a list of wealthy clients can help investors find these opportunities. Private companies prefer this method of raising capital because they retain more control over the business. Investors like the higher returns and equity stakes they make possible. A financial advisor who specializes in this niche provides a valuable service to both issuers and investors.

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